AMT - Why it's a Problem

One tax that seems to annoy both Republicans and Democrats on an equal basis is the AMT (Alternative Minimum Tax). The AMT was designed several years ago to prevent the richest of taxpayers from shielding their income through deductions. Whether or not you think that is a fine tax policy, what cannot be questioned is that the tax no longer serves its original purpose. The bulk of the people I have seen that are impacted by the AMT are married taxpayers with a combined income of $100,000 to $175,000 that own a home and have a few kids. In fact, very few taxpayers who are "rich" are affected by the AMT as their tax rate exceeds the AMT tax rate and many of their deductions and exemptions are phased out by current tax law.

AMT computes an "alternative tax" by eliminating a taxpayer's exemptions, real estate taxes, state income taxes and a few other items. In place of these deductions the taxpayer is given a standard deduction that is subtracted from their income. The result of that calculation is then multiplied by a rate of 26% or 28% depending on the taxpayer's income and this tax is compared to what the tax would be under the regular system. The higher of these two taxes is paid.

So why are so many people getting hit by the AMT?

1) The standard deduction used in the AMT calculation has simply not been indexed for inflation over the years.

2) Over the years, state and local taxes have continued to go up and these are not allowed in the AMT calculation. Put it this way, your real estate tax bill is probably a lot higher now than it was 10 years ago. The AMT deduction has not recognized this simple fact.

3) Reagan's 1986 tax act actually closed several of the loopholes that allowed the super wealthy from shielding their income. That act put limits on the deductibility of passive income and contained other provisions that made it much more difficult to shield income.

There are a lot of proposals out there right now to eliminate or restructure the AMT, but it's hard to see anything being done because it's been a nice revenue boon for government. As it is an "alternate" tax it is not a simple supply side issue either whereby eliminating the tax or cutting the rate will spur increased collections. In other words, it's not a tax policy that influences a person's economic behavior that much. As the proposals come out, we'll look at the pros and cons.

Mike